Tag: capital markets

Understanding the Market Structure of Oil and its Correlation with Bitcoin

Market Highlights 

The price of crude oil dropped below zero for the first time in history. 

Sellers were paying buyers to make deliveries of crude oil in a move to evade the possibility of sustaining storage costs. 

Demand for oil has reduced so much that all the storage facilities are at overcapacity with no interested buyers. 

The downtrend of oil prices started in January after the Coronavirus outbreak and has only accelerated thereafter. 

The low demand for Crude oil is due to various reasons such as the Travel and Aviation ban followed by half of the world currently living under lockdown. 

Before understanding the market structure of the oil, we need to understand that the oil market is a highly manipulated market due to the personal and monetary interests of various stakeholders. Understanding human conflicts, geopolitics, and principles of extraction, storage, and demand are the prerequisites of understanding how the oil market works.

Market History of oil

2004-2008: The demand for crude oil increased after a sustained increase in demand from developing countries. This initiated a parabolic movement of oil’s price as the demand outstripped the supply. Further, the OPEC nations were not interested in upgrading their extraction and storage facilities in order to bring the price of oil to an equilibrium.

2008-2009: The price of oil crashed due to a worldwide recession which reduced the demand for oil drastically and forced OPEC nations to take corrective measures.

2010-2011: The price of oil started increasing from 2010 after the Arab spring which increased political instability and caused fear in markets as the majority of the world’s oil reserves were at high risk including Libya, Syria, Iran, Iraq, Egypt, etc. Further, the economic recovery and increase in demand from India and China for oil increase the price of the commodity.

2011-2012: The OPEC nations came to an agreement to extract more oil thereby increasing the supply in order to supplement the world demand and remove the fears of conflict that had spiraled out of control causing fear in the markets.

2014-2015: The USA started the extraction of shale reserves which reduced the price of oil significantly, pushing Venezuela into an economic meltdown coupled with hyperinflation and sanctions. Further, the OPEC started a price war by letting the price of oil fall hoping that the decline in price would make shale reserves extraction unprofitable leading US shale producers to shut down.

2016-2018: The OPEC agrees to cut its production output in a bid to prop up the price. Various OPEC nations were suffering a serious and dangerous downturn with high costs of extractions as compared to US counterparts, due to which they agreed to decrease the supply in order to reach a better equilibrium price.

2018-2019: USA and EU nations imposed sanctions on Iran thereby cutting off its exports and the demand for oil on the international market. Reducing and weakening the demand for oil from countries like India, China, Japan, Germany, etc.

2020-Present: The price of oil started collapsing from the month of January as international flights started to shutdown. With the aviation and traveling industry under restrictions the demand for oil reduced significantly. As the spread of the virus accelerated and nations all around the world went into lockdown with the suspension of domestic travel, the demand for oil saw a sharp decline, and storage facilities around the world found it difficult to store oil with no buyers in the market.

                                                                                                  

What led to the oil price crash? 

1. The increase in inventory at the rate of 6-7 million barrels per week. 

2. Cushing hub, where a majority of oil is stored saw its facilities completely filled. 

3. Traders who were not able to take the delivery sold it on for the available prices. 

4. The fall in price and the fear of May futures expiring on Tuesday ie, April 21 intensified the selling of oil. 

5. The drop in price triggered mass liquidations and margin calls on various positions held by financial institutions, traders, etc, driving the price down even more. 

6. Liquidation of positions also removes liquidity from the market spreads thereby accelerating the crash with poor liquidity on the books. 

The correlation between Bitcoin and oil: 

The correlation between Bitcoin and oil has always been to the minimum when compared to the correlation between oil and Equities where the correlation is as high as 80%. 

Even though the correlation index between Bitcoin and oil is slow, both of the commodities have a similar market structure, where Bitcoin experienced a parabolic advance in 2017 due to an increase in media attention, due to the ICO rush. After that time, Bitcoin has largely been traveling in a downtrend channel breaking the momentum and rallying due to fundamental time to time. 

Even though we know that Bitcoin halving is right around the corner, the technicals are indicating a steep downturn is possible with the RSI trending towards 0, which represents that the price is overbought and will trend downwards. BBands is also tightening and trending in towards a downward momentum. It is highly unlikely that the blockchain market will face an upturn where there is no economic recovery or rally in the world and people are living paycheck to paycheck. Even though Bitcoin halving is a strong fundamental what is happening around the world negates its benefits as Bitcoin is a high-risk asset class and investors are wary of taking any investment decisions when a global recession is right at the doorstep. 

Further, it is highly unlikely that money from the equity markets and the oil market will move towards Bitcoin and other cryptocurrencies as the institutions are cutting down risk and taking what all they have. Furthermore, retail investors are also personally affected by the lockdown and allocating resources to Bitcoin and cryptocurrencies ignoring that they would need money in the coming months for survival is highly unlikely. 

The analysis provided by the author is purely educational in nature and does not continue any legal, investment, financial, or trade advice. Please do your research before investing or taking any financial decision. 

Image via Shutterstock

References: 

[1] Institue for Environmental Diplomacy and Security, Basic Principles of Economics and Rising Oil Prices, James M. Jeffords Center, the University of Vermont, available at https://www.uvm.edu/ieds/node/468.

[2] A. Mudgill, What led crude oil prices fall below $0 a barrel, Economic Times, dated 22 April 2020.

[3] B. Pulmer, Oil prices keep plummeting as OPEC starts a price war with the US, Vox, dated 28 November 2014.

[4] T. DiChristopher, Oil Suffers its worst monthly drop in more than two years during ugly October for markets, CNBC, dated 31 October 2018.

[5] L. Elliot, Middle East Crisis may leave world over an Oil Barrel, The Guardian, dated 7 February 2011.

[6] J. Baffes et al, The great plunge in oil prices: Causes, Consequences, and Policy Responses, World Bank Group, dated March 2015, available at http://pubdocs.worldbank.org/en/339801451407117632/PRN01Mar2015OilPrices.pdf.

Billionaire Investor Ray Dalio Bearish on Cash Says Central Banks Drive Economy

Billionaire investor Ray Dalio, the Founder and CIO of Bridgewater Associates, asserted that since the 2008 Financial Crisis, the behavior of central banks like the Federal Reserve demonstrates that capital markets are no longer free.

Ray Dalio believes that the Federal Reserve no longer operates within the traditional economic system and is now the market maker. He also expressed that the traditional valuation of cash has been thrown out the window and will make the US dollar less attractive as a reserve currency.

Central Banks Drive Capital Markets

In an interview with Bloomberg, Dalio argued that capital markets are no longer free as they are now driven by the shifting priorities of central banks to own assets they buy and sell.

Dalio told Bloomberg that capital markets, “Are driven by central banks not only their actions but their desire to be an owner of those assets. Their priorities about that ownership when they buy and when they sell are not the same as the classic free-market allocations,” leading the billionaire to conclude that, “The capital markets are not free.

The billionaire highlighted that the Fed’s behavior has changed from putting money on deposit for banks to borrow and lend out—which fuels the traditional credit system and creates fair competition for financial assets—to asset ownership. Consequently, Dalio asserts that the economy and markets are primarily driven by the ownership of assets by central banks.

US Dollar as a Reserve Currency?

Dalio explained that the Feds transition to market maker and the current capital market environment was a consequence of the 2008 Global Financial Crisis. He did concede that without the Fed taking on this role large parts of the US economy would have failed.

In the interview, Dalio also highlighted his concerns for the US dollar as a reserve currency as the flood of cash clearly indicates that the traditional method of valuation no longer applies to cash.

Dalio has been known to be bearish on cash as a reserve currency but still believes cryptocurrencies like Bitcoin are too volatile to be considered as an alternative. He also previously noted that reserve currencies go through cycles and that, just as the British pound was the world’s reserve currency before the US dollar, so too the dollar is now facing reserve status challenges by China. 

Binance Follows Bybit in Appointing Top Compliance Official

Maxwell Baucus, former U.S. senator and ambassador to China, has joined Binance. The top official will become policy advisor and government liaison to the exchange. Given Baucus’s influence in US political circles, the move should support Binance’s expansion efforts within North America, where its Binance US platform operates.

Curiously, news of the appointment comes two days after Bybit revealed a similar appointment, hiring Daniel Lim to lead its legal and compliance team. Lim formerly served as head of legal and compliance for Singapore-based investment bank Daiwa Capital Markets. Two of the world’s largest cryptocurrency exchanges making similar appointments in the same week suggests the market is gravitating towards a more compliant framework as crypto goes mainstream.

Former Chinese Ambassador Joins Binance

Like Binance, Maxwell Baucus maintains close ties with China, where the experienced official served as US ambassador between 2014 and 2017. With a 40-year career prior to that as a senator representing the state of Montana, Baucus has been around the block. Now he’s entering the world of blockchain for the first time, where he will work with Binance’s existing compliance team to facilitate expansion into new territories and approve new products.

Crypto products such as derivatives can only be offered to certain investor groups in some countries. In the US, meanwhile, crypto exchanges must apply for licensing on a state-by-state basis, further complicating the process of obtaining regulatory approval.

While Baucus may be new to crypto, he’s no stranger to financial innovation, and understands the global markets better than most. As a senator, he chaired the Committee on Finance, whose duties included overseeing trade agreements. In a statement, Baucus spoke of crypto having the potential to power “a revolution in how money is managed leading to a fairer and more equitable financial world.”

Bybit Beats Binance to the Punch

Binance’s announcement following hot on the heels of a similar missive from Bybit is likely coincidental, but it’s nevertheless instructive. On March 9, Bybit disclosed the news that Daniel Lim has joined its team, with CEO Ben Zhou explaining that “Daniel will help bolster Bybit’s compliance posture in a fast-changing regulatory environment and sustain our ambition to build trust and provide value for clients around the globe.”

That sounds very similar to what Binance is hoping to achieve through its appointment of Maxwell Baucus. Lim has had an illustrious career of his own, with his role at Daiwa Capital preceded by a decade as senior legal counsel at Dutch bank ABN AMRO. Lim has also worked for HSBC, so has a deep understanding of the banking sector and how it intersects with crypto.

Crypto has come a long way from the wild west days of Mt. Gox, Btc-e, and other first-generation exchanges that lacked suitable fiat onramps, let alone KYC. Back then, the crypto market was so small that regulators could afford to ignore it. Today, crypto has become too large to overlook. Rather than fight it, however, forward-thinking regulators in many countries are choosing to work with crypto exchanges and payment processors, to develop a framework that will support compliance without stifling innovation or neutering crypto’s entire value proposition.

With experienced counsel taking up senior roles in Binance and Bybit respectively, crypto appears to be creeping closer to an era of greater regulatory clarity and broader mainstream acceptance.

Image source: ByBit

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